Method and computer program for tax sensitive investment portfolio management

ABSTRACT

Methods and corresponding systems are provided for managing investment portfolios that includes the steps of identifying at least one security of the investment portfolio to be sold during rebalancing of the investment portfolio, and rebalancing or deferring rebalancing of the investment portfolio based at least in part on a rebalancing threshold for short-term capital gains or losses, investor specified or otherwise. If an implied total short-term capital gain or loss, e.g., a loss or gain that would occur if the at least one security were sold, falls within the rebalancing threshold rebalancing occurs, otherwise rebalancing is deferred for a later time.

This application is a continuation of U.S. patent application Ser. No.10/810,107, filed Mar. 26, 2004, which is incorporated herein in itsentirety by reference.

BACKGROUND OF THE INVENTION

The present invention generally relates to investment portfoliomanagement and individual security selection in the rebalancing ofinvestment portfolios in a tax sensitive manner. More particularly, thepresent invention relates to a methodology and computer systems andprograms designed to consider a particular investor's tax situation inthe rebalancing of that investor's investment portfolio.

Investment advisers offer professional investment advice to investorsthrough many different vehicles. One such vehicle is the separatelymanaged account (“SMA”). A separately managed account is anindividualized portfolio of securities that is owned and held directlyby an investor and typically managed under the discretion of aprofessional investment adviser. To create a separately managed account,an investor works with an investment adviser to define an investorprofile and to develop an investment strategy that reflects thisprofile, taking into account that investor's overall investmentobjectives and goals, risk tolerance levels and tax sensitivities. Atypical SMA program may offer several pre-determined target portfoliosfrom which participants may select, depending upon their investorprofile.

Each target portfolio may contain allocations of securities from variousmarket segments and sectors. The investor's SMA will contain individualsecurities that track the allocations of the selected target portfolio.Periodic rebalancing of the SMA is generally necessary to maintain thedesired target portfolio allocation given that security values fluctuateover time. Generally, an investment adviser will rebalance an SMA on aregular basis such as quarterly and in the event that the imbalance ofthe SMA's portfolio allocations has exceeded a pre-set tolerance level.Rebalancing may also be required in the event that an investor'sinvestment profile changes whether due to life events or otherwise.

Rebalancing or a change of the adviser's strategy, however, alwaysinvolves the purchase and sale of securities that generate costs for theinvestor, including brokerage costs, administrative fees and taxablecapital gains. Capital gains that are characterized as short-term underthe US Internal Revenue Code are taxed at a significantly higher levelthan long-term capital gains. Generally, investors prefer to avoidtaxable capital gains, particularly taxable short-term capital gains, inmaking investment decisions. Certain investors, however, have specialtax circumstances that may cause them to seek the realization of capitalgains or losses.

A number of investment systems and methods have been developed that aredesigned to assist investors in allocating assets within theirportfolios and to help mitigate the costs associated with portfoliomanagement, such as U.S. Pat. Nos. 6,484,151, entitled “System andmethod for selecting and purchasing stocks via a global computernetwork”, and 6,601,044, entitled “Method and apparatus for enablingindividual or smaller investors or others to create and manage aportfolio of securities or other assets or liabilities on a costeffective basis”, United States Published Application Nos. 2002/0174045,entitled “System, method, and computer program product for costeffective, dynamic allocation of assets among a plurality ofinvestments”, 2002/0138386, entitled “User interface for a financialadvisory system”, 2003/0088492, entitled “Method and apparatus forcreating and managing a visual representation of a portfolio anddetermining an efficient allocation”, and 2002/0138381, entitled“Individually managed accounts with multiple style allocations options”,and International PCT Published Application No. WO 01/31538, entitled“Investment advice systems and methods”, each of which is herebyincorporated herein in its entirety. None of these systems or methods,however, provide a decision overlay that is designed to assist investorsin the rebalancing of investment portfolios by identifying specificsecurities for sale by their tax lots in order to fit within a pre-settax tolerance. Accordingly, there is a need for a method and system formanaging investment portfolios that provide investors with a decisionoverlay that identifies specific securities by their tax lot for sale ina manner designed to optimize the tax effects of the security sale withrespect to that investor's individual tax situation.

SUMMARY OF THE INVENTION

The present invention generally provides methods, systems, and computerprograms for managing investment portfolios. An investment adviserhaving discretion over an investor's account will make investmentdecisions according to the investor's stated investment objectives.Because asset values and because the adviser's strategy most likelychange over time, an investment adviser typically will rebalance theportfolio periodically in order to maintain the portfolio's compliancewith the investor's stated investment objectives. Rebalancing involvesthe sale and purchase of select portfolio securities to maintain theportfolio's compliance with the investor's investment objectives. Thereare costs associated with rebalancing, however, such as brokerage,administration and taxes. The present invention generally provides a taxoverlay methodology that identifies an ideal basket of portfoliosecurities for rebalancing in order to manage the investor's exposure toshort-term capital gains or losses, based on a pre-set tolerance levelfor the same.

In one aspect of the present invention, novel methods and systems foridentifying securities within an investment portfolio for sale forpurposes of rebalancing are provided that include the steps ofidentifying an optimal basket of securities across one or more tax lotsof a particular security holding. Depending upon the tax sensitivitypre-set, e.g., by the investor, the basket of securities identified forsale may be across multiple tax lots and may consist of securitiesrepresenting only portions of a particular tax lot.

In another aspect of the present invention, methods, systems andcomputer programs are provided for managing investment portfolios areprovided that includes the steps of identifying at least one investmentportfolio security or a plurality of securities, e.g., an ideal oroptimal set of securities, to be sold in connection with a rebalancingof the investment portfolio, and rebalancing the investment portfolio ifa short-term capital gain or losses, which would result from therebalancing of the investment portfolio, falls within a threshold forshort-term capital gains or losses. The securities to be sold may beidentified in a variety of ways. In one embodiment, the security orsecurities to be sold are identified based on a difference betweensecurities in the investment portfolio and a target portfolio. Inanother embodiment, the securities to be sold are further identified byallocating the security or securities to be sold to at least one tax lotassociated with the security or securities to be sold, and computing animplied total short-term capital gain or loss that would result from thesale of the security or securities to be sold from the tax lot.

In one embodiment, the securities to be sold are allocated to at leastone tax lot associated with the securities to be sold based on at leastone allocation strategy selected from the group that includes allocatingthe securities to be sold beginning with an earlier tax lot of aplurality of tax lots and proceeding to a later tax lot, and allocatingthe securities to be sold beginning with a tax lot of a plurality of taxlots having a higher cost basis and proceeding to a tax lot with a lowercost basis. In another embodiment, the securities to be sold areallocated randomly to a plurality of tax lots. The securities arepreferably allocated randomly, a plurality of times, to a plurality oftax lots associated with the securities to be sold. In this instance, animplied total short-term capital gain or loss that would result from thesale of the plurality of securities to be sold in accordance with eachof the random allocations is computed and the allocation, from theplurality of random allocations, that results in the smallest impliedshort-term capital gain or loss or one that most closely matches apre-set targeted short-term capital gain or loss is selected as theidentified securities to be sold.

The implied short-term capital gain or loss may be for the individualsecurity to be sold, for the aggregate securities, or for the totalshort-term capital gain or loss for the year. Thus, in one embodiment,the portfolio is rebalanced if the aggregate or total short-term capitalgain for the year, which would result from the rebalancing of theinvestment portfolio, falls with a threshold for short-term capitalgains or losses. In one embodiment, the threshold for short-term capitalgains or losses is about 2% of the value of investment portfolio'sassets, which threshold may be defined by an investor.

In another aspect of the present invention, the method for managinginvestment portfolios includes the steps of determining a differencebetween securities in the investment portfolio and a target portfolio,identifying a plurality of securities to be sold based on the determineddifference, allocating randomly, a plurality of times, the securities tobe sold to a plurality of tax lots associated with the securities to besold, computing an implied total short-term capital gain or loss thatwould result from the sale of the plurality of securities to be sold inaccordance with each of the random allocations, selecting from theplurality of random allocations the allocation that results in thesmallest implied short-term capital gain or loss; and rebalancing theinvestment portfolio if the implied short-term capital gain or loss forthe selected random allocation falls within a threshold for short-termcapital gains or losses.

Additional aspects of the present invention will be apparent in view ofthe description that follows.

BRIEF DESCRIPTION OF THE FIGURES

The invention is illustrated in the figures of the accompanyingdrawings, which are meant to be exemplary and not limiting, in whichlike references refer to like or corresponding parts, and in which:

FIG. 1 is a flow diagram of a method for managing investment portfoliosaccording to one embodiment of the invention.

FIG. 2 is a block diagram of a computer system for managing investmentportfolios according to one embodiment of the invention.

FIGS. 3-26 are graphs and tables showing estimated results rebalancingbased on a plurality of rebalancing strategies in accordance with thepresent invention.

DETAILED DESCRIPTION OF PREFERRED EMBODIMENTS

We have found that the transition from short-term gains to long-termsgains is by far the biggest contributor to performance after tax. Thatis, we should not pick any share available for liquidating part of aparticular position. Rather, as the various shares of a particular stockposition may have been acquired over time, we should select the tax lotsupporting our target function, i.e. performance after tax. Accordingly,we provide a strategy for tax lot management, which is an overlayprocess that must not override the investment strategy's primecharacter. As a result, there is still a strong relationship between thetax lot management strategy and the effective portfolio.

The following example demonstrates the importance of tax lot managementand liquidation timing. To that end, assume the following portfolio:Stock A: 17 shares bought @ 20 and 9 shares @ 25; Stock B: 5 sharesbought @ 41 and 7 shares @ 50. Assume further, there is now a change inthe target allocation: 24×A plus 13×B. That is, we need to sell 2×A andto buy 1×B. While there is only one way to buy B, there are three waysto sell 2×A: 1) sell 2×A bought @ 20, 2) sell 2×A bought @ 25, and 3)sell 1×A bought @ 20 and sell 1×A bought @ 25. Assuming the value ofA=23 per share and a 30% tax rate, these three different ways ofliquidating A have the following tax (T) implications for theportfolio: 1) T=max(0,2(23−20)·0.3)=1.80, 2) T=max(0,2(23−25)·0.3)=0.00,and 3) T=max(0,(23−20+23−25)·0.3=0.30. Although the new stock positionsare identical in all three instances, there are different taximplications.

We present three main ways to liquidated securities: FIFO, LIFO, and SI.FIFO generally means that we liquidate beginning with the farthest taxlots. For example, the following tax lot data: 22 shares of stock A arebought at time (2), 17 more at time (3), and another 15 at time (6).With the FIFO strategy, shares are first sold from tax lot (2), then taxlot (3) if tax lot (2) contains less than the shares to be liquidated,followed by tax lot (6). LIFO generally means that we liquidatebeginning with the closest tax lots. With LIFO, shares of A are soldbeginning from tax lot (6), then tax lot (3), and finally tax lot (2).As LIFO is biased towards realizing short-term gains, we do not considerit any further. SI or Specific Identification means that the tax lotsfor every individual share to be sold are selected by choice, e.g., 4shares from tax lot (2), 12 shares from tax lot (3), and 3 shares fromtax lot (6), etc. Ultimately, it is our idea to generate a whole set ofrandomly selected Specific Identifications and select thereafter theone, which fits best our target function under the given constraints.The key idea behind a random approach is the fact that there is noanalytical way of finding “the solution” for path-dependent problemssuch as tax-efficient investing.

Further, we distinguish between constrained and unconstrained methods.Unconstrained means that the portfolio follows perfectly the investmentstrategy and constrained means that the portfolio does not perfectlyfollow the strategy under certain circumstances. For instance, theconstraining variable may be the estimate of the tracking error betweenthe strategy and the portfolio, or any other constraints as discussedbelow.

Referring to FIG. 1, a method for managing at least one investmentportfolio, such as a separately managed account (“SMA”) investmentportfolio, according to one embodiment of the present invention beginsat 100 with identifying or determining whether at least one portfolio isa candidate for rebalancing. A portfolio may be a candidate forrebalancing based on a variety of factors. In one embodiment, theportfolio is identified as a candidate for rebalancing by testing orotherwise determining at 102 if portfolio drift or an imbalance hasoccurred between an actual investment portfolio and a correspondingtarget portfolio. The term “actual investment portfolio” is used hereinto denote an investment portfolio containing one or more securitiesactually held by an investor, which is hereinafter simply referred to asan investment portfolio.

A target portfolio is generally used as a model or benchmark formanaging the investment portfolio in an effort to maintain an investmentportfolio that has securities therein at an allocation that tracks theallocations of the target portfolio. The target portfolio may beexpressed in many ways. The target portfolio may, for example, beexpressed in terms particular types securities or allocations ofparticular types of securities. The types of securities, for instance,may be expressed with reference to the particular market segment and/orsector that particular securities belong, such as small-cap, mid-cap, orlarge-cap classes of securities, aggressive growth, growth, or valueclasses of securities, or a combination thereof. The target portfoliomay further be defined in greater detail or granularity, such as bysubclass, particular securities, quantity, price, etc. For example, atarget portfolio may include 100 shares of A corp., 200 shares of Bcorp., etc.

If at 104 it is determined that a sufficient amount of portfolio drifthas not occurred or that there is no imbalance with respect to theinvestment portfolio allocation, the system may continue monitoring theinvestment portfolio for portfolio drift. If at 104 a sufficient amountof portfolio drift has occurred, e.g., the actual drift is greater thanan allowable or pre-set tolerance for drift, the investment portfolio isidentified as a candidate for rebalancing. An amount of portfolio driftsufficient to trigger rebalancing may be a constant or a variableamount, and may be specified by either the investor or the assetmanagement company. Various factors may be used to determine the amountof drift sufficient to trigger rebalancing, including the cost ofrebalancing, market conditions, etc. For instance, if the cost oftrading particular types of investment portfolio securities that havedrifted is relatively high, a higher portfolio drift or allowable driftmay be tolerated than if the drift occurred with regard to investmentportfolio securities that have a lower trading cost associatedtherewith. In one embodiment, the maximum allowable drift is from about1% to about 5%.

In one embodiment, at 106 a portfolio is identified as a candidate forrebalancing by testing the time from the previous rebalancing of theactual investment portfolio to determine if at 108 a sufficient amountof time since the previous rebalancing has lapsed. If at 108 asufficient amount of time has not lapsed, the system may continuemonitoring the investment portfolio to determine if the investmentportfolio is a candidate for rebalancing based on a periodic rebalancingschedule, e.g., monthly, quarterly, semiannually, annually, etc. If at108 a sufficient amount of time has lapsed, the investment portfolio isidentified as a candidate for rebalancing. The amount of time sufficientto trigger a periodic rebalancing may be a constant or a variableamount, and may similarly vary based on factors, such as the cost ofrebalancing, market conditions, etc.

The target portfolio, i.e., data regarding the target portfolio, of theinvestment portfolio identified as a candidate for rebalancing may thenbe retrieved at 110, e.g., from an investment portfolio database. Asnoted above, the target portfolio may be defined with regard to theallocation of particular types of securities. In this instance, thetarget portfolio data set includes data regarding the allocation ofsecurities. In one embodiment, the target portfolio is defined in termsof particular securities. In this instance, the target portfolio dataset includes a securities identifier, quantity, etc. For example, thetarget portfolio may be defined to include 35 shares of A corp. stock,100 shares of B, 17 of D, 66 of E, of 21 F, and 100 of M. The targetportfolio may be expressed as a vector with each of its elementsrepresenting the number of shares of the according stock position, asshown in Table A.

TABLE A A B D E F M O 35 100 17 66 21 100 0

The actual investment portfolio or stock position data may then beretrieved at 112, e.g., from an investment portfolio database, and maysimilarly be expressed as a vector. For example, the investor's positionwith regard to the actual investment portfolio may include 42 shares ofD corp. stock, 66 of E, 21 of F, 116 of M, and 43 of 0, as representedin Table B.

TABLE B A B D E F M O 0 0 42 66 21 116 43

A difference portfolio may then be calculated or otherwise determined at114. The difference portfolio is generally the difference of particularsecurities, e.g., shares, between the target portfolio and the actualinvestment portfolio, which may also be expressed as a vector, as shownwith regard to the above examples in Table C. The difference portfoliogenerally contains positive and negative elements. The positive elementsindicate securities to be purchased and the negative elements indicatesecurities to be sold. This aspect of the invention generally identifiesat least one security to be sold during rebalancing, e.g., in accordancewith a rebalancing strategy. For instance, the negative element withregard to D securities indicates that 25 shares of D securities are tobe sold to achieve the desired allocation with regard to the targetportfolio.

TABLE C A B D E F M O +35 +100 −25 0 0 −16 −43

An ideal or optimal security or basket of securities to be sold from theinvestment portfolio may then be identified at 140 in a manner to managethe investor's exposure to short-term capital gains or losses. The idealsecurity or basket of securities may be identified from one or more taxlots, or a portion of a tax lot of the particular security holding. Inone embodiment, the ideal or optimal security or basket of securities tobe sold is identified by allocating the securities to be sold at 116 tothe investment portfolio's tax lot or lots, and computing at 118 animplied short-term gain/loss (“STGL”). Tax lots generally representrecorded transactions with regard to the investment portfoliosecurities. Further with regard to the above examples, Table D shows taxlot information for the securities: A, B, D, E, F, M, and 0 securitiesat times T1 to T3. It can be seen, for instance, that 10, 13, and 19shares of D securities were purchased at times T1, T2, and T3,respectively.

TABLE D T1 T2 T3 A +22 +17 (39) −39 (0)  B 0 0 0 D +10 +13 (23) +19 (42)E 0 0 +66 (66) F +42  0 (42) −17 (21) M +130   0 (130)  −14 (116) O +33 0 (33) +10 (43)

It is understood that securities may be identified for sale from theinvestment portfolio tax lots in accordance with various strategies. Forinstance, the negative securities may be allocated according to FIFOwhere securities are selected beginning with the earliest or farthesttax lots and proceeding to the later tax lots. For example, 25 shares ofD securities may be sold out of the T1-T3 tax lots beginning with the 10shares of the Ti tax lot, proceeding to the 13 shares of the T2 tax lotand to 2 shares of the T3 tax lot. Alternatively, or in addition, thenegative securities may be allocated beginning with the tax lots havingthe highest cost basis proceeding to the tax lots with the lower costbasis. In one embodiment, the securities to be sold are identified byrandomly allocating the negative securities from the differenceportfolio to the various tax lots. In this instance, a plurality ofallocations with regard to the negative securities are preferablyperformed by random selection and the implied STGL computed for eachrandom allocation. In this instance, the ideal or optimum security orbasket of securities to be sold from the investment portfolio tax lot orlots is, in one embodiment, the random allocation embodiment thatproduces the most appropriate result given the investors objectives andconstraints, such as the allocation that results in an implied STGLclosest to zero or closest to a desired or targeted capital gain orloss, least portfolio drift or tracking error, beta, aggregated longterm gains, or a combination thereof.

In one embodiment, the computed implied STGL is a net or aggregate STGL,i.e., the sum of the implied STGL for each negative security of thedifference portfolio, rather than the STGL for the individual negativesecurities. In another embodiment, the implied STGTL is applied to therunning year's total STGL (“TSTGL”) at 120 to produce an implied TSTGL.With regard to the embodiment employing a random allocation of thenegative securities, a net STGL and implied TSTGL is computed for eachof the random allocations, and the ideal or optimum security or basketof securities to be sold from the investment portfolio tax lot or lotsis, the allocation that results in the smallest implied net STGL orTSTGL. In one embodiment, the implied TSTGL is expressed in terms of afraction of the investment portfolio's net securities.

The implied STGL, e.g., the individual, net STGL, or TSTGL, for theidentified ideal security or basket of securities may them be comparedwith a pre-set rebalancing threshold or constraint for shorter termcapital gains, such as a constraint with regards to STGL, net STGL,TSTGL, etc., which may be specified by either the investor or the assetmanagement company. The threshold may be defined in various ways, suchas with a lower limit, upper limit, absolute value, etc. Thus, if at 122the implied STGL, or with regard to the random allocations, at least oneimplied STGL, such as the random tax lot allocation which moves theresulting implied STGL closest to zero or smallest STGL, is within thethreshold, e.g., +/−2%, the investment portfolio may be rebalanced at124. In one embodiment the portfolio is only rebalanced if the impliedTSTGL is closer to zero than the actual TSTGL. In another embodiment,the portfolio is only rebalanced if the actual TSTGL is between about+/−2% or between about +/−1%.

Otherwise, the system will block or defer at 128 rebalancing of theinvestment portfolio, and may proceed to monitor the investmentportfolio accordingly for rebalancing. Even if neither the market valuesnor the target portfolio has changed in the interim between the previousassessment for rebalancing the investment portfolio, other conditionsfor rebalancing may have changed, such as a chance in the tax status ofan asset from short-term to long-term.

In some instances, the portfolio drift from the target allocation may besufficiently large to warrant rebalancing the investment portfolio andaccepting the cost associated with the STGL or TSTGL exceeding therebalancing threshold. In this instance, if portfolio drift exceeds amaximum portfolio drift the investment portfolio is rebalanced at 126regardless of the resultant TSTGL.

As noted above, various liquidation strategies may be applied toliquidate negative securities from the difference portfolio. Varioussimulations have been run on a simulated investment portfolio that isbased on historical data derived from the UBS Global Asset ManagementLarge/Intermediate Cap portfolio between 1993-2002 to determine theresult of the present invention on the investment portfolio's rate ofreturn. The simulated investment portfolio has an initial value of$100,000. The following four liquidation strategies have been simulated:FIFO without constraints (“FNC”), FIFO with constraints (“FWC”),specific identification based on random allocations without constraints(“SNC”), and specific identification based on random allocations withconstraints (“SWC”). Constraints generally refers to limiting theoccurrence of rebalancing based on a liquidation strategy that blocks orotherwise defers rebalancing based on a constraining variable, such asshort-term capital gains.

FIFO without Constraints (FNC)

If the liquidation strategy is a FIFO and all positions are consequentlyimplemented as suggested, i.e., without constraints, the cumulativeshort-term gains (STG) and long-term gains (LTG) are shown in FIG. 3 andFIG. 4, respectively, which translates into the net year-end portfolioasset values (“NAVs”) and annual taxes as shown in FIG. 5. The final NAVis $190,321 and the total tax paid is $42,852. Both the cumulative STGand the cumulative LTG are of significant size. As it is the objectiveto realize capital gains at some time, LTG is less important issue atthis stag. Our primary concern is STG which is taxed at a much higherrate but can be easily converted into LTG by waiting the according timefor the tax rate switch to happen. Moreover, short-term losses (STL) canbe carried forward but not back which is a significant constraint of theinvestor's flexibility. Hence, big and lengthy swings as shown in FIG. 3are not recommended, as they are likely to catch the investor off-guard.If an investor wants to liquidate his entire portfolio if the STGaggregation is substantial, he may run out of offsetting options. As aresult, we target an STG-function with frequent swings of a smallmagnitude.

FIFO, with Constraints (FWC)

The same process as in FIFO was applied with the sole difference thatportfolio flows are suspended if this resulted in a STG aggregationlarger than +2% of the portfolio value. Applying this rule, the STG andLTG are shown in FIG. 6 and FIG. 7, respectively. In this instance, STGis under control as its maximum value is four times smaller than in theprevious approach. Again, due to the surge in the stock market, LTGincreases significantly over time, but this time, it does so stepwise,since rebalancing is suspended several times due to the 2% rule. Thistranslates into the year-end NAVs and annual taxes as shown in FIG. 8.The final NAV is $196,630 and the total tax paid is $55,529. The cost ofsuspending or forgoing rebalancing is a proxy tracking error (“PTE”)between the target portfolio and the actual portfolio, which is shown inFIG. 9.

SI without Constraints (SNC)

In this instance, the liquidation process calls for specificidentification of securities by tax lot based on random allocations orpermutations without constraints with the STG, LTG, and NAVs and taxes,as shown in FIG. 10, FIG. 11, and FIG. 12, respectively, and allportfolio changes are consequently implemented as suggested. The finalNAV is $192,646 and the total tax paid is $41,045.

SI with Constraints (SWC)

In this instance, random allocations or permutations were applied withconstraints, i.e., with portfolio rebalancing suspended if the TSTGLwould be greater than ±2% of the portfolio value, which results in aSTG, LTG, and NAVs and taxes, as shown in FIG. 13, FIG. 14, and FIG. 15,respectively. The final NAV is $208,152 and the total tax paid is$40,532. The PTE between the target and actual portfolio is shown inFIG. 16, which indicates that STG are under control with a maximum PTEof 2.83% opposed to the maximal FWC PTE of 4.90%, and at a lesserfrequency of PTE. As shown in FIG. 17, the rate of return associatedwith constrained portfolio rebalancing, according to the presentinvention, is significantly higher than the unconstrained counterparts.The preferred liquidation strategy, i.e., SWC, provides a 100 basispoint advantage over the poorest tax strategy, i.e., FNC, and the PTE israther mild.

Barra Risk Measures

Proxy risk estimates were employed to determine feasibility. The PTEbased on the simulation runs indicate two key dates: March 1997 when allsimulation runs cause a proxy tracking error between 2.5% and 3%, andthe April 1999 when two simulation runs provide a temporary trackingerror of 5%. The resultant Barra measures are shown in FIG. 18. In bothinstances, the portfolio risk is smaller than target portfolio orstrategy risk. The tracking error between portfolio and strategy isreasonable as compared to the tracking error between the strategy andthe benchmark. Overall, PTE seems to slightly underestimate the Barratracking error (by about 15%). The beta of the portfolio vs. thebenchmark is smaller than the beta of the strategy vs. the benchmark.Finally, there is no thesis violation in terms of beta in that both theportfolio and the strategy have a beta that is smaller than one.

FIGS. 19-28 graph the relevant data patterns for 20 simulations. Basedon our research we recommend strongly to avoid a big aggregation of STGwhenever possible. The according price for a temporary suspension ofportfolio adaptation is a tracking error between the portfolio and thestrategy, which, however, proves moderate. The best stock liquidationstrategy is a randomized Specific Identification rather than a(perfectly rigid) LIFO or FIFO. Of course, ‘randomized’ means generationmultiple runs and selection the most appropriate one under the givenobjective and constraints. Our target function is to keep the aggregatedSTG below a certain cap. The main constraint is a tracking error capbetween the portfolio and the strategy. However, this is not necessarilythe only constraint. Other constraints such as beta, aggregated LTG, or(temporary) combination of aggregated STG and aggregated LTG may beother constraints. The tax overlay process can also be highly mechanizedwhich is an important prerequisite. Based on our simulations, theperformance enhancement is on the order of 100 basis points. How big isat some given time depends largely on the given market trend.

The present invention may be implemented in various types of computingenvironments, such as on a single computing device, or on a network ofcomputing devices. In one embodiment, a system for managing investmentportfolios according to the present invention includes a computingdevices having software associated therewith, e.g., on a computerreadable medium, that when executed provides the relevant functionalitywith regard to managing investment portfolios as described above.

Referring to FIG. 2, a system for managing investment portfolio asdescribed herein includes at least one client device 202, 204 connectedover a communication network 206 to at least one server computer, suchas proxy server 212, and/or an application server or servers 214, havingat least one database associated therewith, such as an investmentportfolio database 224. The client devices 204 may further be connectedto the servers 212, 214 though a proxy server 210. In one embodiment,the system includes a mainframe computer 216 that is associated with theinvestment portfolio database 224. The application server and/or themainframe computer preferably include therein software or computerprogramming that when executed identify investment portfolios forrebalancing, and rebalance the investment portfolio within theconstraints noted above.

The communications network 206 is any suitable communications link, suchas a local area network (LAN), wide area network (WAN), the Internet, awireless network, or any combinations thereof. A client device 202, 204is generally a multipurpose computer having a processor and memory thatis capable of communicating with the server computers 210, 212, 214 andalso capable of displaying information received there from. A clientdevice may therefore be a personal computer (PC), special purposecomputer, a workstation, a wireless device, such as personal digitalassistants (PDA), cellular phones, two-way pagers, etc. The clientdevice 202 for instance, may be a terminal for use by an assetmanagement advisor and the client device 204 may be a terminal of aplurality of terminals for similar use in an office setting. Theinvestment portfolio database 224 generally includes therein informationregarding target portfolios and actual portfolios for at least oneinvestor.

While the invention has been described and illustrated in connectionwith preferred embodiments, many variations and modifications as will beevident to those skilled in this art may be made without departing fromthe spirit and scope of the invention, and the invention is thus not tobe limited to the precise details of methodology or construction setforth above as such variations and modification are intended to beincluded within the scope of the invention

1.-22. (canceled)
 23. A method for managing investment portfolios usinga computer system, the method comprising: identifying at least oneinvestment portfolio security to be sold in connection with arebalancing of the investment portfolio; randomly allocating, using thecomputer system, the at least one investment portfolio security to atleast one of a plurality of tax lots associated with the at least oneinvestment portfolio security to be sold; computing, with the computersystem, an implied total short-term capital gain or loss that wouldresult from the sale of the at least one investment security from the atleast one tax lot; and rebalancing, using the computer system, theinvestment portfolio if any of the short-term capital gain or loss,which would result from the rebalancing of the investment portfolio,falls within a threshold for short-term capital gains or losses, and notrebalancing the investment portfolio if any of the short-term capitalgain or loss does not fall within the threshold.
 24. The method of claim23, wherein identifying the at least one security to be sold comprisesidentifying the at least one security based on a difference betweensecurities in the investment portfolio and a target portfolio.
 25. Themethod of claim 23, comprising identifying a plurality of securities tobe sold in connection with the rebalancing of the investment portfoliobased on a difference between securities in the investment portfolio anda target portfolio.
 26. The method of claim 25, wherein identifying theplurality of securities to be sold comprises allocating the plurality ofsecurities to be sold to at least one tax lot associated with thesecurities to be sold and computing an implied total short-term capitalgain or loss that would result from the sale of the plurality ofsecurities from the at least one tax lot.
 27. The method of claim 26,wherein the plurality of securities to be sold are allocated randomly toa plurality of tax lots.
 28. The method of claim 23, wherein thethreshold for short-term capital gains or losses is about 2% of thevalue of investment portfolio's assets.
 29. The method of claim 23,wherein the threshold for short-term capital gains or losses is definedby an investor.
 30. The method of claim 23, wherein the short-termcapital gain or losses which would result from the rebalancing of theinvestment portfolio is computed as a sum of the short-term gain orlosses of each of the at least one investment portfolio security to besold in connection with a rebalancing of the investment portfolio.
 31. Asystem for managing investment portfolios comprising at least onecomputing device having software associated therewith that when executedperforms a method comprising: identifying at least one investmentportfolio security to be sold in connection with a rebalancing of theinvestment portfolio; randomly allocating the at least one investmentportfolio security to at least one of a plurality of tax lots associatedwith the at least one investment portfolio security to be sold;computing an implied total short-term capital gain or loss that wouldresult from the sale of the at least one investment security from the atleast one tax lot; and rebalancing the investment portfolio if theshort-term capital gain or loss, which would result from the rebalancingof the investment portfolio, falls within a threshold for short-termcapital gains or losses, and not rebalancing the investment portfolio ifthe short-term capital gain or loss does not fall within the threshold.32. The system of claim 31, wherein the method comprises identifying aplurality of securities to be sold in connection with the rebalancing ofthe investment portfolio based on a difference between securities in theinvestment portfolio and a target portfolio.
 33. The system of claim 32,wherein the plurality of securities to be sold are identified byallocating the securities to be sold to at least one tax lot associatedwith the securities to be sold and computing an implied total short-termcapital gain or loss that would result from the sale of the plurality ofsecurities to be sold from the at least one tax lot.
 34. The system ofclaim 32, wherein the plurality of securities to be sold are allocatedrandomly to a plurality of tax lots.
 35. The system of claim 31, whereinthe method comprises: identifying a plurality of securities to be soldin connection with the rebalancing of the investment portfolio based ona difference between securities in the investment portfolio and a targetportfolio, the plurality of securities identified by allocatingrandomly, a plurality of times, the securities to be sold to a pluralityof tax lots associated with the securities to be sold, computing animplied total short-term capital gain or loss that would result from thesale of the plurality of securities to be sold in accordance with eachof the random allocations, and selecting from the plurality of randomallocations the allocation that results in the smallest impliedshort-term capital gain or loss.
 36. The system of claim 31, wherein themethod comprises rebalancing the investment portfolio if a totalshort-term capital gain or loss for the year, which would result fromthe rebalancing of the investment portfolio, falls with a threshold forshort-term capital gains or losses, and not rebalancing the investmentportfolio if the total short-term capital gain or loss for the year doesnot fall within the threshold.
 37. The system of claim 31, wherein thethreshold for short-term capital gains or losses is about 2% of thevalue of investment portfolio's assets.
 38. The system of claim 31,wherein the threshold for short-term capital gains or losses is definedby an investor.
 39. The system of claim 31, wherein the short-termcapital gain or losses which would result from the rebalancing of theinvestment portfolio is computed as a sum of the short-term gain orlosses of each of the at least one investment portfolio security to besold in connection with a rebalancing of the investment portfolio.
 40. Asystem for managing investment portfolios comprising at least onecomputing device having software associated therewith that when executedperforms a method comprising: determining a difference betweensecurities in the investment portfolio and a target portfolio;identifying a plurality of securities to be sold based on the determineddifference; allocating randomly, a plurality of times, the securities tobe sold to a plurality of tax lots associated with the securities to besold; computing an implied total short-term capital gain or loss thatwould result from the sale of the plurality of securities to be sold inaccordance with each of the random allocations; selecting from theplurality of random allocations the allocation that results in thesmallest implied short-term capital gain or loss; and rebalancing theinvestment portfolio if the implied short-term capital gain or loss forthe selected random allocation falls within a threshold for short-termcapital gains or losses, and not rebalancing the investment portfolio ifthe implied short-term capital gain or loss does not fall within thethreshold.
 41. A method for managing investment portfolios using acomputer, the method comprising: determining, using the computer, adifference between securities in the investment portfolio and a targetportfolio; identifying, with the computer, a plurality of securities tobe sold based on the determined difference; allocating randomly, usingthe computer, a plurality of times, the securities to be sold to aplurality of tax lots associated with the securities to be sold;computing, with the computer, an implied total short-term capital gainor loss that would result from the sale of the plurality of securitiesto be sold in accordance with each of the random allocations; selecting,by the computer, from the plurality of random allocations the allocationthat results in the smallest implied short-term capital gain or loss;and rebalancing, by the computer, the investment portfolio if any of theimplied short-term capital gain or loss for the selected randomallocation falls within a threshold for short-term capital gains orlosses, and not rebalancing the investment portfolio if any of theshort-term capital gain or loss does not fall within the threshold.